Supply Chain Secrets #33 - Hidden Labor Where Are You?

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In the world of high tech manufacturing labor is often less than 10% of the cost of goods. This leaves people wondering why a country like China can have such a cost advantage. There will be claims of subsidized material cost, undervalued currency and lack of environmental regulation. While these may be legitimate issues, one major factor is typically overlooked, stacked labor content.

 Long ago, companies like American Shoe from Beverly, Massachusetts built shoe-manufacturing equipment by starting with rail cars of iron ore. They ran giant furnaces, cast their own parts, did their own machining and assembled their own product. Over time this strategy fell out of favor as companies focused on their core competencies. Today companies outsource their castings, machining and assembly process. The reason that manufacturing labor doesn’t appear to cost much is because their suppliers do all the manufacturing. The labor content of their product is essentially hidden in their material costs.

Take for example a product that incorporates a $20 sheet metal part. This cost will be accounted for in the materials line in the cost of goods. In reality, the material cost of the part is only $8; the rest of the cost is a supplier’s labor and overhead.  A complex electro-mechanical product that appears to have only 8% labor content; might really be have more than 18% of stacked labor costs. This is not simply an interesting accounting point; it is essential that engineers understand the true cost drivers of their designs. As companies have outsourced more of their manufacturing, engineers have lost sight of the manufacturing processes that turn their computer models into parts.

 The strategy to combat hidden labor is to analyze the real cost drivers of a product. Trace the cost of a product back to its base commodities like labor, oil, and metal. This analysis can help guide the product development team in reducing cost and assist operations with optimizing their manufacturing strategy. Identifying hidden costs like labor can enable companies to design cost out from the start thus gaining a competitive advantage in the market place. 

About ThreeCore

Tom Petersen is the Managing Partner of ThreeCore, an operational consulting firm in Beverly, Massachusetts.  Tom consults for multinational companies engaged in the design and manufacture of high-tech products. His team is dedicated to helping companies create competitive advantages using innovative strategies and process-driven improvement. For more information go to www.threecore.com or follow Tom on twitter @3CoreConsulting.